The Power of Outside Options

An outside option is one’s opportunity cost for bargaining—i.e., the utility one would receive if he terminated negotiations. Better outside options lead to more favorable bargains. This is because your opponent must give you a larger share of the surplus for you to not want to reject and pursue the outside option. While this may seem intuitive, people often fail to exercise outside options to obtain bargaining leverage.

This lecture also marks a shift in the course. Previously, explored the utility of proposal power. Now we switch gears to learning the other sources of bargaining power. We will generally use the ultimatum game for these purposes because it is the easiest form of bargaining to manipulate.